David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Multi-Chem Limited (SGX:AWZ) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Multi-Chem Carry?
You can click the graphic below for the historical numbers, but it shows that Multi-Chem had S$4.76m of debt in December 2020, down from S$23.3m, one year before. But it also has S$67.6m in cash to offset that, meaning it has S$62.8m net cash.
How Strong Is Multi-Chem's Balance Sheet?
The latest balance sheet data shows that Multi-Chem had liabilities of S$140.6m due within a year, and liabilities of S$6.02m falling due after that. On the other hand, it had cash of S$67.6m and S$125.0m worth of receivables due within a year. So it can boast S$46.0m more liquid assets than total liabilities.
This surplus strongly suggests that Multi-Chem has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Multi-Chem has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Multi-Chem grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Multi-Chem's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Multi-Chem may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Multi-Chem recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Multi-Chem has S$62.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in S$46m. The bottom line is that we do not find Multi-Chem's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Multi-Chem you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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